Account Receivable Factoring

Business financing is challenging in any environment, and there are a variety of circumstances that may limit the options for a bank loan. As an alternative, many companies now utilize accounts receivable factoring as a method of raising immediate cash.

Understanding Factoring

Accounts receivable factoring revolves around the concept of selling a company’s invoices at a discount in exchange for immediate capital. Since invoice factoring is not an actual loan, the transactions do not appear as debits on the balance statement.

Each individual invoice is discounted based upon the creditworthiness of the invoiced customer rather than the client. This allows those companies requiring financial assistance to obtain funding that is not dependant on their own credit rating.

The Factoring Process

Obtaining accounts receivable financing is an uncomplicated process. In most cases the application is two pages, and approval is usually received within 48 hours. A balance sheet, profit and loss statement, and a selective representation of invoices can also be required.

Once the account is established, the factoring company will begin to assess the client’s customers on an individual basis. They will analyze credit histories, payment records and industry trade statistics while applying a numerical value to each customer. This will ultimately determine the percentage they will lend on the respective receivables. It is important to note that the client controls which invoices are submitted for factoring.

Typical factoring loans range from 60-80% of the invoiced amount. Factoring fees are usually 3% on receivables that are paid current. Fees rise for past due bills and can be as much as 9% for invoices that are in the 90 column. When the full payment is collected by the lender, they will subtract their fee and immediately transfer the difference into the client account.

Factoring Advantages

There are numerous benefits to accounts receivable factoring including:

• Immediate funding: All factored proceeds are wire transferred by the next business day.

• Invoice eligibility: Upon approval of the client’s customer, most invoices are eligible for financing up to 60 days from the date of purchase.

• Free credit checks. There is no charge for checking the credit worthiness of a client’s customer. If an invoice isn’t accepted for factoring, the company may reconsider extending any credit to that particular customer.

• Credit rating protection: Immediate cash can provide relief from vendor obligations and other pressing debt matters.

*Reduced collection costs: Since the receivables are purchased, the factoring agent initiates all collection procedures.

Additional Considerations

Although factoring is a useful financial tool, it is important to recognize its limitations and consequences. When compared to a bank, accumulated factoring fees will usually exceed the annualized interest rate charged on a commercial loan. Debt factoring agreements that include recourse will result in the reassignment of bad debts in excess of 90 days back to the client. Collection efforts by the factoring agent can be aggressive and sometimes result in strained relations for the client and customer.